“If the Fed is right, then this market is a screaming buy,” Mr. Delisle said. “Admittedly, the Fed's outlook is likely to be revised lower as the year progresses, but as optimistic as their scenario may seem now, we would note that bullish scenarios always look the most outrageous in stormy periods.”
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Federal Reserve: Best-case scenario
Monday, February 23, 2009
In its economic update released last week, the U.S. Federal Reserve forecast that the U.S. economy would contract 0.9 per cent in 2009 and then improve to 2.9 per cent growth in 2010. Wishful thinking? Vincent Delisle, a strategist at Scotia Capital, believes so – but he looked at how the S+P 500 is likely to respond under the Fed's best-case scenario, Scotia's base-case scenario and a worst-case scenario.
The Fed's scenario would likely translate into S+P 500 aggregate per-share earnings of $65 (U.S) in 2009 and $80 in 2010, up from $55 in 2008. Attach a price-to-earnings ratio of 16 onto those figures, and the implied price targets for the S[amp]amp;P 500 would be 1050 in 2009 and 1275 in 2010. During late-morning trading on Monday, the S[amp]amp;P 500 was down to 763.
“If the Fed is right, then this market is a screaming buy,” Mr. Delisle said. “Admittedly, the Fed's outlook is likely to be revised lower as the year progresses, but as optimistic as their scenario may seem now, we would note that bullish scenarios always look the most outrageous in stormy periods.”
Unfortunately, he puts the Fed's best-case scenario at just a 20-per-cent chance of success (ouch) – or even odds with the worst-case scenario. That one looks like this: Stress conditions in credit markets stir again, throwing a cold towel on improving economic conditions. Earnings for the S[amp]amp;P 500 fall to $45 a share in 2009 and improve only slightly to $55 in 2010. As a result, the implied price targets (using a lower P/E ratio) for the S[amp]amp;P 500 would fall to just 550 in 2009 and 650 in 2010 – suggesting another bout of volatility.
Depressed? At least the base case scenario has a 60-per-cent chance of success, in Mr. Delisle's view, and looks reasonable for equity markets. Under this scenario, U.S. gross domestic product contracts 2.9 per cent in 2009 and rises 1.7 per cent in 2010, which is gloomier than the Fed's estimates. S[amp]amp;P 500 earnings flat-line at $55 this year and rise to $70 next year. Using a P/E ratio of 14 (mid-way between the best-case and worst-case scenarios), the implied target for the index is 850 in 2009 and 1000 in 2010.
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